Dalio, speaking at a Fox Business panel at Davos, Switzerland’s global annual summit, lamented that interest rates had been lowered too much for too long by central banks in a stimulus campaign to combat the 2008-09 economic downturn. This led to investors flooding into riskier assets like stocks, he noted.
Compounding that was the Federal Reserve’s recent push to jack interest rates back up, but they did it too fast, he said.
The Fed moved “to tighten monetary policy at a level that was faster than the capital markets could handle and, as a result, we had a correction,” he said, pointing to its four hikes in 2018. Only lately has the Fed indicated it might ease off in 2019.
“We had an important change in Fed policy regarding what the direction of Fed policy will be in that tightening,” he said, adding that the “growth rate will slow, probably in a self-reinforcing process.”
At the same time, he added, rates aren’t high enough to give the Fed room to then lower them significantly as a tool to fight the next recession.
Fellow panelist and UBS Group Chairman Axel Weber agreed, saying that rates “in most of the western world were very low for very long, and markets have gotten used to that.” Weber added that rates may have been “too low” for the economic environment for the “better half” of the past five years. “When they started lifting rates, they tightened rates in a late-cycle stage,” he said.
Weber said that we might be going through a “soft spot” in the economy and that monetary policy normalization should come later. “They won’t get it done this time because the economy is weakening, and so I think it will be ‘mission aborted,’” he said. “They will look at normalizing rates in the next cycle, and then react to a slowing economy in the next year or two by a more muted, more cautious, more data-driven approach.”
Weber still has “one or two” rate hikes penciled in.
According to Dalio, China “has the power” to handle the slowing of its growth rate and the impacts of that cycle, but he is wary of how the US and Europe will be able to deal with the issue when it hits.
Next year, with presidential elections in the US, he also noted the proposal by Rep. Alexandria Ocasio-Cortez (D-New York) for a 70% maximum income tax, which aims to hit the ultra-wealthy, will be an issue.
“What scares me the most longer term is that we have limitations to monetary policy which is our most valuable tool at the same time we have greater social and political antagonism,” he said. “The next downturn in the next economy worries me the most.”
Since our rates are still low, albiet rising, Dalio is concerned they are still too low where the Fed would not have enough time to give the US economy the shot in the arm it would need by dropping those rates if there were an economic problem.
He compared the current state of affairs to the environment of the late 1930s.
“[In] 1929-1932, we had a debt crisis. Interest rates hit zero. Then there was a lot of printing of money. Purchases of financial assets drives financial prices higher. It creates also, a polarity, a popularity, and an antagonism,” Dalio said. “We also had then at that time, the phenomenon of a rising power, like China, dealing with the conflict of an existing power. These types of political issues are now very connected to economic issues and policy.”
In an interview on CNBC’s Squawk Box, Dalio said there is “significant risk” of a recession in 2020.